You need to know how VIX is calculated in this modern age and how it works so you can use it to support your financial decisions.
Investment is the best choice for income, and understanding VIX and its parameters are crucial in making suitable investments.
VIX is short for Volatility Index and is a crucial part of stock marketing and planning for buying and selling shares.
Let us look at all the aspects that come together to create a VIX value and what the real-life translation of the value is;
How Is VIX Calculated?
The Chicago Board of Options Exchange is the body responsible for calculating VIX. It uses the S&P 500 market prices and call options with about a 30-day expiry date. The calculations also rely on weekly SPX options that expire on Friday.
S&P 500 index always has specific stocks, but the VIX constitutes a constantly shifting SPX options portfolio. Here is a simplified step-by-step breakdown of the calculation;
- Choose the options you want to have in your VIX calculation so you can generate a range of call and have two strikes within two consecutive expirations in approximately the 30-day mark.
- Calculate how much each option in your selection contributes to the total variance of its expiration.
- Add all the variances from the options to get a total variance for the two expirations.
- Interpolate the two variances to get the 30-day variance. This calculation will depend on when each of the groups expires.
- You must get the volatility as standard deviation by taking the square root.
- Multiply the new value (standard deviation of volatility) by 100, and the answer is VIX.
The VIX values are quoted in percentage; hence you multiply them by 100 at the last step. This calculation will predict the stock price changes in the S&P 500 over the coming 30 days.
You can annualize this value for 12 months to get a long-term prediction. The formula has been used since it was launched in 1993 by Professor Robert Whaley of Vanderbilt University. Analysts and investors use this to make investment decisions in the stock market.
What Do VIX Numbers Mean
Now that you can calculate the VIX, you need to know the value you get from your calculations. The Volatility Index is used as a measure of how unstable the market is.
By this rule, a higher volatility index means the market is highly unstable, and the trading environment is choppy.
A VIX value above 20 is generally high, and one below 12 is low. Anything between 12 and 20 is a standard value of a stable market.
The Vix registers a high number when there are more activities on the options used in the calculation.
This means that the investors are selling more of their shares. Some prefer to buy shares during such times.
The idea is that when the VIX is high, it has probably reached its peak and is bound to come back down. This allows investors to buy shares at a lower price and get a better deal when the VIX lowers.
When the VIX falls, it is an indication that investors are buying call options. Investing in a call is the equivalent of betting that the stock price will rise prior to the contract expiring. A falling VIX implies an optimistic sentiment in the stock market.
Although the VIX isn’t a percentage, you ought to look at it as one for the values to make more mathematical sense.
Understanding these patterns and when to sell or buy shares is the core of stock marketing, and it will make all the difference in your profits.
How To Interpret VIX
To apply it appropriately in your stock marketing plans, you need to know what each VIX value implies.
This is a comprehensive field of study among analysts and traders, so let us get into its real-life applications and see what it can do for you;
As a general description, a lower VIX value implies stability in the market. VIX values of below 20 or below mean it is low risk. A VIX of about 30 means more uncertainty and rapid shifts in the market.
Because of the relationship, VIX is sometimes called the “fear index.” When it increases, there is a lot of turmoil and fear in the market; when it drops, everything becomes more stable.
There are numerous ways to interpret the VIX, but you need to keep one thing in mind, this is not a sure thing; it is a theoretical measure from a math formula.
It tracks values that can be affected by non-mathematical entities; therefore, it is not always on point.
VIX uses options prices to create an estimate of what the market trend in the future will be like. This means that VIX measures implied volatility rather than actual volatility. Emotion can drive the stock market significantly.
A company’s stock could report growth during earnings season, but then the shares tumble since the company didn’t live up to analyst expectations.
This is a common occurrence, and it does not indicate a fault in the company or VIX, just a change in the market demographic.
A lot of changes in the market can be broken down into feelings such as greed. Most investors spot increased potential in companies and place orders to buy shares, increasing the prices even more.
Fear is also significant, as most investors want to keep their investments safe. They will therefore sell their shares which will drive prices lower. In the worst cases, this selling can cause a tailspin in the market and lead to capitulation.
VIX is not a tool for causing panic; it simply gauges market volatility. Some expert traders use the increased turbulence as a signal to buy, allowing them to profit through hedging or speculation.
Can VIX Go Over 100?
You now have a rule-of-thumb idea of how VIX works and what each aspect of it means. As it increases, the market becomes more unstable, so how bad can it get? Let us get into the details and find the answer to this;
Based on the process of calculating the VIX, it can theoretically go above 100 if the standard deviation value is big enough.
However, it has never gone that high since data collection started in 1990, but it has reached some high points in the recent past.
On October 24th, 2008, the US went through a financial crisis that started with the global implosion of mortgage-backed securities. The VIX hit an all-time high of 89.53, which was a crazy time for most traders.
Another major event that affected the VIX was the more recent Coronavirus pandemic. On March 16th of, 2020, at the start of the pandemic, the VIX was at 82.69. Real-life events significantly affect the VIX, and drastic changes can happen overnight.
According to analysts, the VIX would have gone higher than 100 had data collection started in the 1980s. The Black Stock Market Crash on October 19th, 1987, would have been enough to get the VIX to 100.
What Are The VIX’s Current Volatility Predictions
You now know how the VIX works, and you might be curious about what it has in store for you. It has been a crazy few years in the trading demographic, and the trend does not seem to be making a significant improvement.
The looming threat of inflation has caused issues in Tech Stocks, high P/E ratio stocks, and the NASDAQ.
Investors are selling and buying shares more to keep up with the unpredictable market changes, which affects the VIX as it is dynamic.
The start of these issues was the Coronavirus pandemic, and it took the market over 2 years to recover from that blow.
As the pandemic ended and the market got some form of normalcy, the Russia/Ukraine conflict escalated into a war.
Russia is the world’s largest oil producer, and oil is critical for most parts of the business; therefore, their participation in the war affected all companies across the globe. It has caused supply chain issues and price and interest rate hikes.
China’s zero COVID policies have dented the US business infrastructure. All these factors combine to create storm clouds that raise concerns about a recession among experts.
You now know how VIX is calculated and what a VIX value means. The Index uses percentages, and you can use the number to determine the market’s stability. A VIX of below 20 indicates a stable, stress-free market.
A VIX value of above 30 means there is more instability in the market. As you learn more about trading, you can use the VIX to make more informed financial decisions in buying and selling shares. This will help you turn a profit in the long run.